Archive » August 31, 2006

Estate Planning

By Amanda Thomas and Jim Tombor

TAX DEFERRAL STRATEGIES AND CHARITABLE GIVING

On August 17, President Bush signed the most extensive revision of the nation’s pension law in three decades, which sets standards that companies must follow in funding their pensions. The law requires companies to fully fund defined-benefit pension plans over seven years, effectively closing loopholes that allow under-funded plans to skip payments and forcing companies that under-fund their plans to pay higher premiums to the Pension Benefit Guaranty Corporation. An estimated 30,000 pension plans are now under-funded and will be required to contribute more money into their plans. The Labor Department estimates that plans are approximately $450 billion under-funded.

Although new rules for defined benefit plans account for more than half of the Pension Protection Act, the new law also addresses retirement savings held in IRAs, 401(k) and other defined contribution plans. These provisions affect tens of millions more taxpayers than do the pension rules. In addition, the law tightens the rules for claiming charitable contribution deductions, yet at the same time attempts to stimulate charitable activity.

The new law bolsters the future of defined contribution plans in two ways. It makes permanent a long list of benefits introduced by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that had been scheduled to sunset after 2010. And, it covers an array of other matters, including the rules affecting the transfer of 401(k) accounts and other so-called defined-contribution plans, upon death.

Before the revision, Federal law allowed a spouse who inherited a 401(k) account to transfer the funds into his or her own retirement account without penalty. But anyone else – a sibling, domestic partner or child of the deceased – typically has been required to take distributions from the 401(k) over the period elected by the decedent, or five years, if no such period was elected. Under the new provision, other heirs will be able to roll an inherited 401(k) account into an Individual Retirement Account (IRA) and not pay tax on the income immediately and perhaps not for years. A non-spouse heir’s tax payment schedule will be tied to the age of the account’s former owner. Experts say the rule, which takes effect next year, could save many heirs from an unnecessary and premature tax burden.

In addition, the annual contribution limit on 401(k)s – currently $15,000 – was set to increase every year for cost-of-living until 2011, at which point it was scheduled to fall back to $13,000. The new legislation makes permanent the $15,000 level plus annual cost-of-living adjustments. Also, workers over 50 years old may contribute an additional $5,000 to their 401(k) accounts on top of the federal contribution limit. The provision was set to expire in 2011, but the new legislation makes it permanent and calls for the catch-up amount to be adjusted for cost of living. The law also makes permanent the higher dollar amount for IRA contributions of $4,000 starting this year, $5,000 in 2008, and inflation adjusted thereafter.

Another provision guarantees that earnings and qualified distributions from “529 plan” college savings accounts will remain exempt from federal taxes, a provision that had been set to expire in 2010. This benefit is demonstrated in the following example: A contribution of $7,000 per year (assuming an 8% rate of return) to a 529 plan for a new child or grandchild would result in $311,000 after 18 years, which will be the estimated cost of a California public college education. About 9 million children are currently enrolled in these plans, with assets of approximately $92 billion.

The new law also contains provisions aimed at stimulating charitable donations and curbing abuses. The most significant provision will allow taxpayers over the age 70.5 years old to make tax-free donations up to $100,000 from their IRA to charitable causes this year and next year only. This change in the law creates additional tax planning opportunities for individuals with significant net worth.

In a major change, no deduction is allowed for any contribution of cash, check or other monetary gifts unless the donor can show a bank record or the charity can provide a written verification. In prior law, documentation was only required for cash contributions of $250 or more. The new recordkeeping requirements give taxpayers no leeway. For non-cash contributions such as clothing and other household items, the new law requires the donated items to be in “good condition.” Of course, the new law does not define “good condition” with respect to the donated items.

Local Nexus

The conservation tax incentive is of particular significance to Santa Barbara landowners and the community at large. The law provides significant tax benefits for landowners who grant conservation easements to qualified Land Trusts and public agencies. The maximum deduction a donor can take for donating a conservation easement is increased from 30% to 50% of adjusted gross income for donations made through December 21, 2007. Qualifying farmers and ranchers can deduct up to 100% of their adjusted gross income. Additionally, the provision extends the carry forward period for a donor to take tax deductions for a voluntary conservation from five years to 15 years. The majority of donations are made to community-based charities dedicated to conserving wildlife habitats, protecting open space and historic resources. Recent examples of conservation easements include Arroyo Honda, Carpinteria Bluffs and El Capitan Ranch. “The new law provides a benefit for longtime Santa Barbara families who are agricultural land owners, as it opens up a window of opportunity to get value out of their land without having to sell or subdivide it,” says Michael Feeney, executive director of the Land Trust of Santa Barbara County.

The new law also addresses taxable distributions and deductibility requirements for contributions to Donor Advised Funds. In addition, as it pertains to Private Foundations, the new law expands the tax base on net investment income, and provides new rules on taxable distributions to supporting organizations. There are many details to these new requirements, and one should consult a tax advisor for additional information.

There were many changes brought about by the Pension Protection Act of 2006, and the above information highlights those provisions that pertain to high net worth taxpayers. To maximize the benefits encompassed in the law, a comprehensive review of your estate with your tax advisor or financial planner is highly recommended.

(Ms Thomas is director of client relations at Mission Wealth Management, LLC, a Registered Investment Advisor. Jim Tombor, MS, CPA, is a tax manager with Bartlett, Pringle & Wolf, the Tri-Counties leading accounting firm. For more information on this and other related subjects, Amanda and Jim can both be reached at 963-7811.)